Monday, May 10, 2010

Algorithms and Wall Street

The crazy events of Wall Street last week sent off a huge wave of confusion as to the events that led to the sudden drop in stock prices. At first it was thought to be a "fat finger" that cause the decline of major stock indexes. Now the focus is on the large trading farms of computers that are said to make trades by specific rules and algorithms. Now there is a question as to what are the underlying algorithms that these computers are trading. What was thought to be a no brainer of setting trades at the speed of electrons to make a more efficient market is now all being thrown into question.

I do not claim to understand the rules or algorithms that are programmed into these trading computers. Wall Street trading is not my area of expertise. Although I am curious at this overall crisis and how it could be the result of supposed computer rules. The U.S. government is interested also as they are investigating what caused the sudden drop. Can algorithms imposed to trade on a whim cause that much market capitalization to drop out so suddenly. There are claims that market values dropped by nearly 100% on long established companies like Accenture.

I'm definitely going to be following this story closely. I'm curious what the SEC is going to find in their investigation. I'm going to reserve my opinions until more facts are brought forth. Perhaps we may never really know what caused this crisis. I would hope that it is something the Operations Research community could learn. We know that algorithms can be developed to provide great benefits to people and organizations. Yet we hardly ever hear of the times when they can cause great trouble. We can learn from those bad implementations of algorithms. Usually at the heart of it is not so much a bad algorithm but the underlying assumptions of the model. We should know this all to well with the recent mortgage crisis. Perhaps this road to recovery out of this current recession is going to take a lot more time than we thought.